Third Party Beneficiaries and Privity of Contract

01 / 01 / 2011

“Privity of contract” is an important term in contract law. The concept is simple; legal disputes arising out of a contract are limited to the parties to the contract. Nine times out of ten if you are not a party to a contract, you do not have a breach of contract claim. This article is about that one time out of ten.

Imagine yourself as a new homeowner, but amidst your joy you discover a defect: the foundation is uneven and when it rains, flooding occurs. You immediately call the builder, but it is out of business, so what do you do, who do you turn to? The answer is the legal theory known as “third party beneficiaries.” Being aware of this theory MAY allow you to enforce a claim against the builder, or the subcontractor(s) who excavated, formed up, and/or poured the foundation.

In Illinois, when parties enter into a contract for the benefit of a non-party, that non-party may sue for breach of contract. The rationale is efficiency. If a non-party cannot sue the breaching party to the contract, they’d have to sue the non-breaching contracting party, who would then in turn sue the breaching party. Such round about litigation makes little sense and the courts in Illinois agree. Yet, Illinois courts are reluctant to find that there are third party beneficiaries with enforceable rights. The courts seem to prefer the position that only parties to the contract are bound by that contract.

The question is: “How do you defeat the court’s preference and establish yourself as third party beneficiary with enforceable rights?” Said another way, “How can you sue to recover for that defect in your home when you were not named in the construction contract”? The good news is there is no hard and fast rule. The bad news is also that there is no hard and fast rule. The courts review third party beneficiary claims on a case by case basis.

The most predominant factor in determining third party beneficiary status is intent. The intent of the parties at the time the contract is executed will determine your status as a third party beneficiary. The factors Courts use in determining intent vary, but the language in the contract will always be considered. Language in the contact which identifies you as a third party beneficiary will make your status as a third party beneficiary easy to ascertain. However, having your name placed in the contract may be easier said than done.

If you find yourself fighting to have this language in the contract, keep in mind the underlying principal of intent and ways this can be determined. Another consideration in determining intent is whether a party was foreseeable by the contracting parties. However, forseeability is not alone sufficient. In public works contracts there are many foreseeable beneficiaries. Parties to public works contracts such as those for the construction of a road or sewer, do not anticipate being sued by the numerous users of the road or sewer and so the courts have yet to find third party beneficiary status in a public works contract. The point to keep in mind is whether the breaching party to the contract would anticipate being sued by an alleged “third party beneficiary?” This is a predominant factor in determining intent.

To provide additional insight, consider the case where a surveyor inaccurately surveyed a piece of land, causing inaccurate boundaries to be recorded. Subsequent purchasers attempted to sue the surveyor, arguing that they were the intended beneficiary of the contract between the prior owner and surveyor. The Court disagreed, preventing the subsequent owners from asserting a breach of contract claim. Yet, courts have found owners to be third party beneficiaries where contracts between builders and subcontractors make reference to “the owner”. The reference to the owner does not need to say, “this is for the direct benefit of Joe Smith”. Simply requiring consultation with the owner in the terms of the contract is sufficient indication of the parties’ intent.

The bottom line is intent. So, when the time comes for your to build a new home or even purchase a new home, it is important to consider your available remedies in the event of a defect. In some cases, inserting language to establish yourself as a third party beneficiary may be a viable option. In other instances, recognizing the unavailability of recovery from a subcontractor may allow you to seek alternative protection in the event you subsequently discover a defect.